Illiquidity and the Wealth Effect

Sebastien Galy
2003 Social Science Research Network  
Investors' attitudes towards risk and the resulting impact on prices in financial markets are determined by changes in their wealth. This wealth effect, however, provides a poor explanation of the observed distribution of futures prices for reasonable values of the degree of risk aversion. This paper shows that illiquidity in the futures market, modeled endogenously as a trading cost, increases the strength of the wealth effect for the same degree of risk aversion. The resulting distribution of
more » ... ing distribution of futures prices presents a more pronounced left fat tail and left skewness than would have been implied by the wealth effect alone.
doi:10.2139/ssrn.381400 fatcat:uyxscekprvcitax3542cvmles4